Question

13.

According to the Capital Asset Pricing Model, which of the following securities is likely to have the highest expected return?

The stock of a firm whose beta is slightly above 0

The stock of a firm, whose beta is slightly above 1

The stock of a firm, whose expected return is equal to the expected return of the market

3-month U.S. Treasury Bill

The bond, whose expected return is equal to the market risk premium

Answer 1

Option 2 is right

Beta represents the degree of volatility of a stock. IF the beta is greater than 1 it implies that the stock is more volatile than the market. Hence every change in the market return will yield a greater than propotionate rate on the stock. Hence option 1 is incorrect

As per CAPM, Expected return = Rf + Beta*(Rm-Rf)

Hence option 3 is incorrect since if the return is equal to risk free rate, it is not the highest return. Alsooption 4 is incorretc since if the expected return is equal to market premium, it isnot the highest.Beta amplifies the return.